Thesis

AEP Industries ("AEPI") is a New Jersey-based plastic film packaging manufacturer that focuses on the North American market, a relatively stable business that earns a spread over resin price inputs.  The industry has consolidated quite a bit in the past few years to two main players, AEPI and Apollo-owned Berry Plastics ("Berry").  This has been a pretty good business over time, earning a pretax ROIC in the mid-teens, and management is comfortable running it with 3x EBITDA leverage.  Currently, AEPI's business is modestly depressed due to the severe downturn in the housing market and it should see a nice boost to earnings when those volumes recover.  For 2011, the company has guided to 840-850m lbs of resin and $65m Adj EBITDAS (add-back LIFO reserve, $21m D&A, 2m SBC).  This implies $41m Adj EBIT, or ~$0.05/lb, which is below the 1998-2010 average of $0.057 EBIT/lb.  I believe that the company will do $80m+ Adj EBITDAS looking out a couple of years and at 6x EBITDA the company is worth north of $50/share at that point.

The CEO, Brendan Barba, founded the company in 1970 and the CFO, Paul Feeney, has been there since 1988.  Management owns 1.3m shares or 24% of the company.  On June 21. 2011, the company announced that it repurchased 650k shares, or 11% of the company, in a privately negotiated transaction.

Management internally thinks company is worth 7x EBITDA based on history and comparable transactions.  They have been net shares repurchasers over time, with sharecount down from 8.6m shares in 2006 to 5.5m today after the most recent repurchase.

Management adds back the LIFO reserve in its Adj EBITDAS numbers.  As of 2011 Q1, the LIFO reserve was $35.5m.  My numbers in the table above are adjusted for the LIFO addback.

AEPI has been written up on this website several times before, most recently in October 2009 by gearl1818.

Business Description

AEPI is a manufacturer of plastic films.  The business is relatively straightforward.  AEPI has thousands of customers, ranging from mom & pop companies to Wal-Mart, and sells thousands of types of plastic films.  AEPI has 12 plants around the country, each with 20-25 lines, with a line producing several million pounds of film.

Sales breakdown by category:

Custom Films - 34% of sales - box & carton liners, furniture & mattress bags, films to cover high-value products, barrier films.  Over 20,000 products so some stickiness to customers.  Modestly higher margin than other segments.

Stretch Wrap - 31% of sales - pallet wrap

Specialty Films - 24% of sales - retail & institutional films, can liners, agricultural films

Polyvinyl Chloride Wrap - 10% of sales - food & freezer wrap.

The company will sell roughly 840m lbs of product in 2011.  Much of the demand is somewhat recession resistant (think plastic food wrap), but a component is tied to more cyclical sectors (construction-related films) that is currently at very low levels, hard to say how much but I would guess up to 20% of volumes.  This is more or less a GDP-linked industry.  In SEC filings, you can see volume and price data back to the late 1990's.

AEPI is mainly a "spread" business; the company tries to earn a relatively fixed amount over its input costs of resin prices.  Historically, the business has been reasonably stable, with AEPI doing roughly $0.18/lb in gross profits, $0.12/lb in opex, and $0.06/pound in EBIT.  There is a decent amount of quarter-to-quarter cyclicality due to fluctuating input prices, but AEPI is usually able to pass those through to customers in relatively short order.  Management claims that gross profits/lb going ahead should be in the $0.18-0.21/lb range going ahead, and they speak fairly confidently that they will get to the higher end of that.  In recent years, resin prices have exhibited more volatility than they have historically, and AEPI tries to fight that as best it can.

Looking at its history, the company attempted an aggressive international expansion in 1996 with its $255m debt-financed purchase of Borden's Global Packaging group, but that business never really panned out due to sub-scale & labor flexibility issues, and management finally exited it completely with the sale of its Netherlands division in 2008.  The company's aggregate financials don't look great as a result, but if you look at the North American results, they have been very stable over time.  It is fair to dock management for that venture, but their focus for years has been on the North American market.

Industry

AEPI and Berry are the two leading players in the space.  Berry is owned by Apollo Management, which purchased it in 2006 from Goldman Sachs Capital Partners, which purchased it in 2002 from First Atlantic Capital, which purchased it in 1990.

According to management, AEPI & Berry each have ~ 35% market share in the national categories and ~ 15% market share in Custom Films, which tends to be a much more localized business.  Both AEPI and Berry have scooped up other top 5 players out of Chapter 11 in the past two years, AEPI buying Atlantis Plastics in a Chapter 11 sale in October 2008, and Berry buying Pliant out of Chapter 11 in October 2009.  I note that these bankruptcy filings in the industry have recurred over time due to resin price volatility and heroic amounts of leverage applied by private equity sponsors.

Notes

Capital allocation - The focus is on share repurchase, tuck-in acquisitions, and debt paydown.  As noted above, the company just completed a repurchase of 11% of shares outstanding in a block purchase.  AEPI management claims that a number of players in the industry are struggling right now due to resin price volatility and that they are looking at a number of small acquisitions.  Debt is at a bit of a peak right now due to the recent share repurchase and working capital increases and should come down over the next few quarters.

Activism - Several funds have filed 13-D's on AEPI in the past few years and management responded by inserting a poison pill.  One shareholder in particular, KSA, made some fairly bold claims about the value of the business and demanded the company be put up for sale.  See letter at link below.  I think management is unlikely to sell at anywhere close to current prices, but I believe that they have a strong incentive to create shareholder value given their significant equity holdings.

http://www.sec.gov/Archives/edgar/data/785787/000091957409016017/d0145194_13d-a.htm

Management - This is a family run business, with the management ranks full of all manner of in-laws.  I personally don't see this as a huge negative, but I don't expect a sale anytime soon.